frbclv_wp1993-05.pdf

Working Paper 9305

GENERATIONAL ACCOUNTING IN NORWAY: IS THE NATION OVERCONSUMING ITS PETROLEUM WEALTH?

by Alan J. Auerbach, Jagadeesh Gokhale, Laurence J. Kotlikoff, and Erling Steigum, Jr.

Alan J. Auerbach is a professor of economics at the University of Pennsylvania and an associate of the National Bureau of Economic Research; Jagadeesh Gokhale is an economist at the Federal Reserve Bank of Cleveland; Laurence J. Kotlikoff is a professor of economics at Boston University; and Erling Steigum, Jr. is a professor of economics at the Norwegian School of Economics and Business Administration, Bergen. The authors would like to thank Carl E. Gjersem for excellent research assistance and Olav Ljones and Dennis Fredriksen of the Central Bureau of Statistics in Oslo for providing estimates from the microsimulation model MOSART. This research was financed by the Norwegian Research Council for Applied Social Science.

Working papers of the Federal Reserve Bank of Cleveland are preliminary materials circulated to stimulate discussion and critical comment. The views stated herein are those of the authors and not necessarily those of the Federal Reserve Bank of Cleveland or of the Board of Governors of the Federal Reserve System.

October 1993

http://www.clevelandfed.org/Research/Workpaper/Index.cfm

Abstract

This paper uses generational accounting to assess Norway's fiscal position. Generational accounting measures the remaining lifetime net tax burdens facing different living generations. It can also be used to compute the percentage difference between the average net tax burden facing future generations and that facing current newborns under existing fiscal policies. Although the Norwegian government imposes sizable burdens on current generations, it also consumes a large share of total national output. Our calculations indicate that despite the government's positive net wealth, current policies imply net tax burdens on future Norwegians that are about twice as large as those facing current young generations.


I. Introduction

This paper uses a new method, called generational accounting, to assess

Norway's long-term fiscal position.' Generational accounting determines

whether a country's current fiscal policies can be sustained without requiring

future generations to pay higher net taxes (taxes paid net of transfers

received) over their lifetimes than current generations pay.

Understanding the sustainability of the current level of net taxation,

though important for any country, is particularly interesting in the case of

Norway. Unlike most countries, Norway has a large, positive stock of govern-

ment wealth due mainly to its considerable petroleum resources. Based on

conventional macroeconomic analysis, which emphasizes the amount of government

debt, the fact that the Norwegian government has a net surplus would suggest

that its fiscal house is fully in order. But this does not mean that it will

have positive net wealth forever. Indeed, Norway's budget deficit, as conven-

tionally measured, is expected to reach 6 percent of GDP in 1993. Even if the

budget deficit were zero, projected demographic changes as well as projected

increases in the scale of Social Security benefits raise the question of

fiscal sustainability.2 So too does the government's high and growing level

of purchases of goods gnd services.

In short, then, this paper considers whether Norway is consuming its oil

and other wealth too rapidly, with the consequence that future generations of

Norwegians will not benefit from that wealth to the same extent that current

generations have. Our main findings suggest that this concern is real, that

current Norwegian fiscal policy is not sustainable, and that the continued

failure to adjust government policy will leave future Norwegians facing

1 See Auerbach, Gokhale, and Kotlikoff (1991, 1992a, 1992b, 1993, 1994) and Kotlikoff (1992). 2 See Kotlikoff (1992) for a detailed critique of the deficit as a measure of an economy's fiscal position. 3 For an early study of this issue, see Steigum and Thogersen (1992).


lifetime net tax burdens that could well be twice as large as those

confronting today's children based on current law. While the precise size of

this generational imbalance depends on the assumed rate of return the govern-

ment earns on its assets, the disparity is large even under quite high

interest-rate assumptions.

The next section describes the Norwegian economy and provides an overview

of its fiscal policies. Section I11 explains the method of generational

accounting. Section IV summarizes the data used to construct the accounts,

leaving a more detailed description for the appendix. Section V presents the

accounts, discusses their implications and sensitivity to assumptions, and

provides comparisons with generational accounts for the United States.

Section VI summarizes our findings and draws conclusions.

11. he Norwegian Economy and Fiscal Policy - A Brief Description Norway is a small country with 4.3 million inhabitants and a highly open

economy. Exports accounted for 43 percent of GDP in 1992, almost one-third of

which were petroleum products, primarily oil and natural gas. Living stan-

dards are quite high compared with those of most other OECD countries. In

1992, per capita GDP totaled $24,600. As indicated in table 1, the nation's

huge petroleum resources - estimated to equal about 41 percent of GDP, or

$34,640 per capita - are a prime source of this wealth.

About 86 percent of Norway's petroleum assets are directly or indirectly

(through taxation) owned by the government. In addition, the government has a

substantial stock of wealth resulting from its generation of hydroelectric

power. It also has considerable financial reserves, with total government

wealth exceeding Norwegian GDP by a factor of more than 2.5.


Norway's proven oil reserves amount to 17 years of production at the

current rate. Starting from zero in 1971, production increased to 132 million

tons oil equivalents (mtoe) in 1992, making the nation a larger producer than

the United Kingdom. According to the government's recent Long Term Program

1994-1997, this trend will continue throughout the rest of the 1990s, with

production expected to peak at 165 mtoe in 2000 and then to head downward to

137 mtoe in 2010 and 87 mtoe in 2030. Norway is also rich in natural gas

xeserves, which would last for 111 years at the current rate of production.

Extraction, however, is expected to increase substantially over the next 10 to

15 years.

Like almost all OECD countries, Norway's population is getting older.

Table 2 shows how this aging process will play out through the next century.

The projections, which are taken from the Long Term Program 1994-1997 and

Gjersem (1993), assume that the current fertility rate of 1.89 percent will

prevail in future years and that life expectancy will continue to increase.

The share of the population that is of working age (19 through 64) is

projected to rise over the next 20 years and then to reverse course. The

percentage of Norwegians over age 65 is now 0.163, but by 2050 that figure

should hit 0.203. The dependency ratio of 0.702 (the ratio of those age 18

and below plus those age 65 and above to those age 19 to 64), already quite

high, is expected to fall to 0.650 by 2015 and to begin increasing thereafter,

reaching 0.731 by the year 2050.

By international standards, Norway has a massive public sector. Table 3

compares key fiscal ratios for Norway, the United States, Italy, Japan,

Germany, and France in 1992. Of the six countries, Norway's 0.551 ratio of

total government outlays to GDP is the largest. The U.S. ratio of 0.354 is

the smallest. While Norway's transfer payments to GDP ratio of 0.226 is


somewhat below that of France, its 0.260 ratio of direct government consump-

tion plus investment spending is the highest of the six. Not surprisingly,

Norway also ranks first in the ratio of taxes to GDP. In fact, the only

category in which Norway's fiscal policy compares favorably with those of the

other five countries is the ratio of net debt to GDP. The government's net

financial assets are a positive 17.2 percent of GDP. By way of comparison,

Italy's net financial assets are a negative 105.3 percent.

Table 4 presents the principal components of the Norwegian government's

expenditures and receipts in 1992.~ Transfers total 29 percent of GDP, of

which 6.41 percent represents subsidies, primarily agricultural. The current

universal Norwegian Social Security system was established in 1967, though

old-age pensions will not be fully phased in until the middle of the next

century. The system is fairly generous and is basically financed on a pay-as-

you-go basis. In 1992, public expenditure on o.ld-age pensions amounted to 6.8

percent of GDP, while disability pensions, sickness allowance, and unemploy-

ment benefits totaled 7.5 percent. Another important transfer is family

allowance, which amounted to 2.4 percent of GDP in 1992. Old-age pensions are

expected to grow rapidly in the years ahead, due both to demographics and to

the phase-in of the new pension system.

Public consumption spending represented 22.43 percent of GDP in 1992,

much of which was traceable to government workers' wages. About 30 percent of

total employment is in the public sector. The second largest component of

public consumption spending represents expenditures on health and education

As table 4 shows, the government runs a considerable deficit (3.62

percent of GDP) despite its huge wealth. In part, this stems from the recent

4 Note that some of the figures in this table differ from those in table 3 due to differences in classifications.


recession, which triggered a shift to an expansionary fiscal policy stance in

the beginning of the 1990s. It also reflects investment in the petroleum

sector, which in 1992 accounted for 32 percent of the budget shortfall

reported in table 4. Current projections show the deficit rising to 6 percent

of GDP in 1993, of which 43 percent represents direct investment in the

petroleum sector.

Table 4 also indicates the important role of indirect taxes and Social

Security contributions to Norway's public finance. In addition to a large

value-added tax (VAT), there are substantial consumption taxes (excise taxes)

on cars, gasoline, alcohol, and tobacco. Excluding petroleum taxes, most

direct taxes are on labor income. Capital taxes are low in Norway. Private .

households are heavily indebted due to the deductibility of nominal borrowing

costs. In fact, aggregate capital taxes from private households are negative,

i.e., the government is, on average, subsidizing capital income. Property

taxes are also a minor item.

In 1992, the statutory tax rate for capital income was reduced to 28

percent and the maximum marginal tax rate on labor income was cut to about 50

percent. Overall, the effect of this reform has been to increase corporate

income taxation and to reduce personal capital income taxation.

111. ~ e t h o d o l o ~ ~ ~

Generational accounting is based on the government's intertemporal budget

constraint. This constraint, written as equation (I), requires that the

future net tax payments of current and future generations be sufficient, in

present value, to 1) cover the present value of future government consumption

5 This section provides a brief description of the method of generational accounting. For a more detailed explanation, see Auerbach, Gokhale, and Kotlikoff (1991).


and 2) pay off the government's initial net indebtedness,.

D cQ cQ (1) I: N t , t-s + = Nt,t+S = I: G~ (I+,) t-s - WE

s=o s=l s=t

The first summation on the left-hand side of (1) adds together the genera-

tional accounts (the present value of the remaining lifetime net payments) of

existing generations. The term NtJk stands for the account of the generation

born in year k. The index s in this summation runs from age 0 to age D, the

maximum length of life. 6

The second summation on the left-hand side of (1) adds together the

present value of remaining net payments of future generations. The first term

on the right-hand side expresses the present value of government consumption.

In this summation, the values of government consumption in year s, given by

Gs, are discounted by the pre-tax real interest rate, r. The remaining term 6

on the left-hand side, Wt, denotes the government's net wealth in year t.

Equation (1) indicates the zero-sum nature of intergenerational fiscal

policy. Holding the present value of government consumption fixed, a reduc-

tion in the present value of net taxes extracted from current generations (a

decline in the first summation on the left side of [I]) necessitates an

increase in the present value of future generations' net tax payments.

The term N is defined by tJk

6 Hence, the first element of this summation is NtSt, which is the present value of net payments of the generation born in year t; the last term is N f , t-D the present value of remaining net payments of the oldest generation a lve in year t, namely, those born in year t-D.


Here, T stands for the projected average net tax payment to the government s ,k

made in year s by a member of the generation born in year k. The term Ps,k

stands for the number of surviving members of the cohort in year s who were

born in year k. For generations born prior to year t, the summation begins in

year t. For generations born in year k, where k > t, the summation begins in

year k. Regardless of the generation's year of birth, the discounting is

always back to year t.

A set of generational accounts is simply a set of values of Nt,k, one for

each existing and future generation, with the property that the combined

present value adds up to the right-hand side of equation (1). Though we

distinguish male and female cohorts in the results presented below, we

suppress sex subscripts in (1) and (2) to ease notation.

Note that generational accounts reflect only taxes paid less transfers

received. With the exception of government expenditures on education, which

are treated as transfer payments, the accounts do not impute to particular

generations the value of the government's purchases of goods and services.

Therefore, the accounts do not show the full net benefit or burden that any

generation receives from government policy as a whole, although they can show

a generation's net benefitburden from a particular policy change that affects

only taxes and transfers. Thus, generational accounting tells us which gener-

ations will pay for government spending, not which will benefit from that

spending.

Assessing the Fiscal Burden Facinp Future Generations

Given the right-hand side and the first term on the left-hand side of

equation (I), we determine, as a residual, the value of the second term on the

right-hand side, which is the collective payment (measured as a time-t present


value) required of future generations. Based on this amount, we determine the

average-present-value lifetime net tax payment of each member of each future

generation under the assumption that the average lifetime tax payment of

successive generations rises at the economy's rate of productivity growth.

Without this growth adjustment, the lifetime net tax payments of future gener-

ations are directly comparable to those of current newborns, since the genera-

tional accounts of both newborns and future generations take into account net

tax payments over these generations' entire lifetimes.

Note that our assumption that the generational accounts of all future

generations are equal, except for a growth adjustment, is just one of many

possible conjectures about the distribution across future generations of their

collective net payment to the government. We could, for example, assume a

phase-in of the additional fiscal burden (positive or negative) to be imposed

on new young generations. Clearly, this would mean that generations born

after the phase-in period has elapsed would face larger lifetime burdens (the

Nt,k's) than those calculated here.

IV. Constructing Generational Accounts

To form generational accounts for current and future generations, we need

1) proj'ections of the population by age and sex, 2) projections of average net

taxes for each generation in each year in which at least some of its members

will be alive, 3) a discount rate to convert flows of net taxes into present

values, 4) an estimate of the initial stock of government net wealth, and

5) projections of future government consumption. We describe the data sources

and procedures for obtaining this information in general terms here, and

provide a detailed description in the appendix.


Po~ulation Proiections

The projection of population by age and sex from 1992 through 2050 is

taken from The Long Term Program 1994-1997, a fiscal planning document issued

by the Norwegian government. We have extended these projections through 2200

by assuming that fertility and mortality rates after 2050 equal those

projected for that year.

Proiection of Taxes and Transfers

Our projections of average future taxes and transfers by age and sex

begin with the 1992 official totals for all levels of government (central and

local). All taxes and transfers are considered in this analysis. Taxes are

categorized as VATS, auto'excise and gasoline taxes, alcohol and tobacco

excise taxes, Social Security contributions, income taxes, and personal wealth

taxes. Transfer payments are categorized as old-age support, health, educa-

tion, old-age pensions, disability pensions, sickness allowance, family

allowance, unemployment benefits, and other Social Security.

We distribute the 1992 totals of each of these taxes and transfers by age

and sex based on corresponding distributions in cross-section survey data.

The primary sources for these distributions are the 1990 Income and Wealth

Survey and the 1990 Survey of Consumer Expenditure. The Income and Wealth

Survey sample contains 8,287 households with 22,349 members. The Survey of

Consumer Expenditure contains 1,201 households with 3,216 members. The

appendix provides further details concerning the construction of the cross-

section tax and transfer distributions.

The result of distributing the various aggregate taxes and transfers by

age and sex is a 1992 distribution of benchmarked average payments by age and

sex for each type of tax and transfer. We assume that, except for produc-


tivity growth, all distributions hold for future years. Thus, if we assume a

0.75 percent rate of productivity growth, the projected distribution of taxes

and transfers by age and sex for, say, 2020 equals the 1992 distribution

multiplied by 1.0075 raised to the twenty-eighth power.

The sole exception to this procedure arises in the case of old-age

pensions. The Norwegian Social Security system is relatively young, and

higher old-age pension benefits are to be phased in over time. To accommodate

this fact, we used the MOSART model (a microsimulation model constructed by

the Norwegian Central Bureau of Statistics) to project future distributions of

old-age pensions by age and sex.

Discount Rates

The appropriate discount rate for calculating the present value of future

amounts depends on whether or not they are known with certainty. Future

government receipts and expenditures are risky, which suggests that they be

discounted by a rate higher than the real rate of interest on government

securities. On the other hand, government receipts and expenditures appear to

be less volatile than the real return on capital, suggesting that they be

discounted by a rate lower than that. Our baseline calculations assume a 4

percent real discount rate, which appears to be close to the current average

real rate earned by the Norwegian government on its net financial wealth.

Government Consum~tion

The present value of government spending on goods and services is

estimated based on the assumption that spending grows over time (from its 1992

level) to keep pace with population plus productivity growth. This amounts to

assuming that spending per capita rises at the productivity growth rate.


Given the projected absolute stream of spending, forming its present value is

a simple matter of discounting.

Our estimate of spending includes infrastructure investment rather than

the imputed rent on the existing stock of infrastructure. Our failure to

impute rent on Norwegian government infrastructure (other than the

electricity-generating sector and the public telephone company) does not,

however, appear to bias our calculations. The reason is that, to a first

approximation, the present value of the future imputed rent on new infrastruc-

ture investment should equal the amount of the investment.

In the case of existing infrastructure, such as the Norwegian fjords, we

ignore both the value of the stock (in calculating the government's net

wealth) and the future imputed rent (in calculating the present value of

government spending). To a first approximation, these adjustments would

cancel from the right-hand side of equation (1) and therefore would leave

unaltered our calculation of the net tax burden facing future generations.

Government Net Wealth

Our measure of government net wealth is the sum of five components: net

financial assets, the market value of publicly owned stock, the present value

of income from the sale of petroleum, the present value of the net cash flow

from hydroelectric power plants, and revenue from the public telephone

company. The appendix describes the data sources and calculation of each of

these items.


V . Findings

Basic Results

Tables 5 and 6 present the basic generational accounts for Norwegian

males and females for the base year of 1992. For cohorts ranging in age from

0 to 95 in 1992, each table includes nine sets of calculations, corresponding

to three real, before-tax interest rates (2, 4, and 7 percent) and three rates

of multifactor productivity growth (0.25, 0.75, and 1.25 percent). The center

column corresponds to our base-case assumptions of a 4 percent rate of

interest and a 0.75 percent rate of productivity growth.

For males in the base case (table I), the generational account is

$129,900 for newborns, rising to a peak of $295,200 for those who turned 25

in 1992. Thereafter the account falls, becoming negative at age 60 as indi-

viduals approach retirement and, with it, a reduced level of income taxes and

public pension benefits. In interpreting this pattern, it is important to

remember that a generation's account equals the present value of its remaining

lifetime net tax payments. Thus, one cannot directly compare the accounts of

different current generations to determine their relative lifetime burdens.

For women (table 6), the lifetime pattern is similar for the base case,

but the accounts at each age are generally much lower. Newborns in 1992, for

example, face a net lifetime fiscal burden of just $5,600. This difference

can be understood by looking at more detailed information presented in tables

7 through 10.

Tables 7 and 8 repeat the generational accounts for males and females for

the base case, decomposing the results into the components of household

payments and receipts. Comparing these two tables, we see that taxes on

income and labor earnings explain most of the gender-related differences. As

a result of their lower rate of labor force participation and their lower


earnings when employed, females born in 1992 will pay $86,200 less in income

and payroll taxes. In addition, women receive higher lifetime benefits.

Their higher public pensions result from greater longevity, although a large

share of general social welfare payments and most family benefits go to women.

Tables 7 and 8 also permit a number of other interesting observations

regarding the Norwegian fiscal system. One is the importance of indirect

taxes. For males, roughly one-third of all lifetime taxes are indirect (VATS

plus specific excise taxes); for females, the share is one-half. On the

receipts side, the largest program for both men and women is education. While

pension benefits are larger in absolute terms, they are received much later in

life and hence have a smaller present value than education benefits.

This difference in timing is exhibited in tables 9 and 10, which present

the annual-flow components of the base-case accounts for a single generation

- 1992 newborns - over 10-year intervals. Each row in the table gives the

actual payments and receipts that a representative member of the cohort will

receive as he or she ages. The present values of these flows are presented in

the rows of tables 7 and 8. As one would expect, the tables indicate a

smoother lifetime pattern of consumption taxes than of income taxes. Because

income taxes include taxes on capital income, they occur, on average, later in

life than payroll taxes. On the receipts side, again as expected, education

benefits occur very early in life and pension benefits quite late. This

explains why the lower annual flows for education result in much larger age-0

present values. As a comparison of the tables for males and females shows,

men's pension benefits are actually greater than women's in each year. Thus,

the higher present value for women is entirely attributable to their greater

longevity.


The Fiscal Burden on Future Norwe~ians

Having considered the accounts for existing generations in some detail,

what can we say about future generations? Let us return to tables 5 and 6,

which present at the bottom the fiscal burdens that must be borne by future

generations in order to satisfy the government's intertemporal budget

constraint. For the base case, we estimate that future generations face net

payment burdens that, adjusted for growth, are 133 percent higher than those

faced by 1992 newborns. This indicates a severe imbalance in generational

policy. However, it is important to consider how dependent this finding is on

a variety of assumptions.

As discussed above, there are wide ranges of interest rates and economic

growth rates that could plausibly be used in calculating generational

accounts. How much do our conclusions hinge on the particular base-case

combination used thus far? Tables 5 and 6 provide the answer, giving current

and future generational accounts for nine different interest-rate/growth-rate

combinations. The results indicate that the finding of a severe generational

imbalance does indeed depend on our parameter assumptions.

The net-payment burden of a given generation is the sum of the present

values of different streams of taxes and transfers, some of which occur

earlier and others later during the generation's remaining lifespan. Hence,

the relationship between the net-payment burden and the rate of interest may

not be monotonic. Tables 5 and 6 show that the percentage difference between

the accounts of newborn and future generati0ns.i~ smaller the higher is r. 7

This difference is quite sensitive to the values of r and g used in the

7 Note that the percentage difference is adjusted for growth and is calculated as ([Nf/((l+g)*Nn)] - 1) x 100, where Nf is the net-payment burden on future generations and Nn is that on current newborns.


calculations, and it is large and positive for a range of plausible values of

these parameters.

For a given value of r, a higher value of g implies larger payments and

receipts the further in the future that these occur. Again, however, because

the timing of taxes and transfers is generally different over the lifespan,

values of g and of the net payment need not be related in a monotonic way for

particular generations. Table 5 shows that higher values of g produce larger

present-value net-payment burdens for future as compared to current genera-

tions and result in a larger percentage difference between the accounts of

future and newborn generations.

The Imvact of Petroleum Wealth

As mentioned above, one of the distinctive features of the Norwegian

economy is its considerable government wealth, due primarily to its energy

resources. Because of its prominence, petroleum wealth is often used as a

benchmark for questions about Norway's fiscal status. For example, we might

relate the size of Norway's current generational imbalance to its stock of

petroleum wealth, or ask how changes in the value of the nation's energy

resources affect its fiscal position.

One way of addressing the first question is to ask to what extent govern-

ment spending out of its petroleum wealth would have to be reduced to restore

generational balance. For the base case, in which there is initially a gener-

ational imbalance of 133 percent, we find that a permanent reduction in

spending of 22.0 percent would be required. In 1992, this would mean a reduc-

tion of $1,329 per person in government spending, which equals about two-

thirds of Norway's estimated 1992 income from its petroleum wealth.


Of course, the nation's actual petroleum wealth might change over time.

Because the value of energy resources is highly sensitive to the volatile

prices of oil and natural gas, significant unexpected increases or decreases

are quite plausible. Our calculations indicate that a decline in petroleum

wealth could have a severe impact on the well-being of future generations.

For the base-case assumptions about interest and growth rates, halving the

value of petroleum wealth raises the generational accounts of the unborn by

62.6 percent - an absolute amount of $82,000 for males and $3,500 for

females. Thus, declines in petroleum wealth due to world oil price changes

could have an important impact on Norway's generational balance.

Comparing Norwegian and U.S. Generational Accounts

How do our findings for Norway compare to those for the United States?

Table 11 presents comparative generational accounts for the two countries

according to our base-case interest- and growth-rate assumptions. The

accounts for the United States correspond to those presented in earlier work

(see Auerbach, Gokhale, and Kotlikoff [1993]), except that an interest rate of

6 percent was used previously. The Norwegian accounts are those given above

for the base case in tables 1 and 2, except that educational spending is

included in other government spending rather than treated as a transfer

payment. We treat educational spending in this manner for the sake of

comparison, because this significant component of government purchases has not

been allocated by age and sex for the United States. As can be seen by

comparing the accounts for Norway in table 11 to those in the center columns

of tables 1 and 2, including educational spending with other government

purchases of goods and services raises the accounts for future generations and


for those current generations young enough to have benefited from such

spending.

In addition to the overall accounts for each generation, table 11

presents breakdowns of payments and receipts similar to those given for Norway

in tables 7 and 8; but aggregated somewhat to permit a standard categorization

for the two countries. As table 11 indicates, Norway has significantly higher

levels of generational accounts for almost all current male generations. Some

young female generations, however, bear slightly lower net-payment burdens

compared to current younger female generations in the United States. For a

given level of government purchases per capita, this may translate, via the

government budget constraint, into a much lower burden on future generations

in Norway. However, while the percentage increase in the burden on future

generations is somewhat lower in Norway, the absolute burden on future

Norwegians still exceeds that faced by future Americans. The reason for this

is that Norway not only is raising more revenue from its current citizens, but

is also spending more on government consumption. While the two countries have

similar values of GDP per capita, government purchases represent 26 percent of

Norway's GDP, compared to 19 percent for the United States (see table 3).

Achieving Generational Balance - Three Illustrative Policies

What changes in taxes and transfers would be required to restore the

generational accounts of newborn and future Norwegians to fiscal balance? By

fiscal balance, we mean that the ratio of the net-payment burden on future

generations to that on newborns should be no higher than the rate of multi-

factor productivity growth. Table '12 shows the effects on the accounts of

current and future generations of three alternative ways of achieving fiscal

balance. The first column shows that the average VAT rate would have to be


raised by 48 percent. This would involve substantial increases in the burdens

on young and middle-aged generations: For example, 30-year-old males and

females would be required to pay more than $30,000 in additional VATS. The

net-payment burden on future male generations would fall by about $144,000,

while for future female generations it would rise by $23,000.

As shown in column two of table 12, the effect of raising payroll (SST)

taxes by about 37 percent would be similar, except that current older genera-

tions would pay somewhat less, and middle-aged and younger male generations

somewhat more, than under the first policy. All current female generations

would, however, pay lower additional amounts under the second policy. The net

gain to future male generations would be $143,000, while the loss to future

female generations would be about $9,000 - substantially lower than under the

first policy.

Alternatively, as column three in table 12 indicates, pension (PEN)

benefits could be reduced by about 52 percent to achieve fiscal balance. In

this case, those under age 40 would lose less while older living generations

would lose significantly more in present value as compared to the first

policy. Under the third policy, the burdens on future male generations would

fall by $166,000, while those on future females would increase by about

$5,000.

VI. Summary and Conclusion

This paper uses generational accounting, a new tool for fiscal analysis

and planning, to study Norway's long-term fiscal position. The findings are

quite unsettling. Despite having one of the highest rates of taxation in the

OECD and a sizable amount of public wealth, Norway's fiscal policy appears to

be unsustainable. Unless adjustments are made and made soon, future genera-


tions of Norwegians are likely to face a much higher fiscal burden than that

now in place.

There are many different ways to restore generational balance to

Norwegian fiscal policy. One is to reduce government spending by roughly one-

fifth. Another is to set aside (not spend) about two-thirds of the country's

petroleum income.8 A third option is to limit any further growth in the

generosity of Norwegian old-age pensions. Finally, the government could raise

taxes. While Norway's leaders will ultimately have to decide how and when to

make the necessary adjustments, they can use generational accounting to ensure

that whatever increased fiscal burden they impose on current generations is

distributed fairly. They can also use it to check, on an ongoing basis, that

their largess to current Norwegians does not come at the price of higher

fiscal burdens on future citizens.

8 Steigum (1993) provides an analysis of such a policy.


References

Auerbach, Alan J., Jagadeesh Gokhale, and Laurence J. Kotlikoff, "Generational Accounts: A Meani~gful Alternative to Deficit Accounting," in D. Bradford, ed., Tax Policv and the Economv, vol. 5. Cambridge, Mass.: MIT Press, 1991, pp. 55-110.

, , and , "Generational Accounting: A New Approach to Understanding the Effects of Fiscal Policy on Saving," Scandinavian Journal of Economics 94(2), June 1992a, pp. 303-18.

, , and , "Social Security and Medicaid Policy from the Perspective of Generational Accounting," in J. Poterba, ed., Policv and the Economy, vol. 6. Cambridge, Mass.: MIT Press, June-1992b, pp. 129-45.

, , and , "Generational Accounts and Lifetime Tax Rates, 1900-1991," Federal Reserve Bank of Cleveland, Economic Review, vol. 29, no. 1, 1993.

, , and , "Generational Accounting: A Meaningful Way to Evaluate Fiscal Policy," Journal of Economic Persvectives, forthcoming, 1994.

Franco, Daniele, Jagadeesh Gokhale, Luigi Guiso, Laurence J. Kotlikoff, and Nicola Sartor, "Generational Accounting - The Case of Italy," Federal Reserve Bank of Cleveland, Working Paper No. 9208, August 1992.

Gjersem, Carl E., "Aging Populations: Projections for Norway, 1990-2200," Working Paper 51/1993, Center for Research in Economics and Business Admin- istration, Bergen, Norway, 1993.

Kotlikoff, Laurence J., Generational Accounting - Knowing Who Pays. and When, for What We S~end. New York: The Free Press, 1992.

, "From Deficit Delusion to the Fiscal Balance Rule - Looking for an Economically Meaningful Way to Assess Fiscal Policy," Journal of Economics, Suppl. 7, 1993, pp. 17-41.

Long Term Program 1994-1997. St.meld. nr.4 (1992-93). Ministry of Finance, February 1993.

Steigum, Erling, Jr., "Accounting for Long-run Effects of Fiscal Policy by Means of Computable Overlapping Generations Models," in S. Honkapohja and M. Ingberg, eds., Macroeconomic Modelling and Policg Imvlications. Amsterdam: Elsevier, 1993.

Steigum, Erling, Jr., and Oystein Thogersen, "Petroleum Wealth, Debt Policy and Intergenerational Welfare: The Case of Norway," Norwegian School of Economics and Business Administration Discussion Paper 09/92, September 1992.


Table 1

Norway's National Wealth Per Capita, 1992

Physical capital Natural resources Human capital Net financial assets

National wealth

Assumptions: Exchange rate: 6.65 kroner per dollar Real rate of return: 7 percent per year Productivity growth: 1 percent per year

Source: Central Bureau of Statistics.


Table 2

Norwayr s Demographic Trans it ion

Population (millions) 4.25 4.60 4.66 4.42 Working age (percent) 58.8 60.6 57.8 57.2 Dependency ratio .702 .650 .731 .749

Share of population over age 65 ,163 .I64 .203 .208 over age 75 .070 .068 .lo6 .lo3

Source: Gjersem (1993).


Table 3

Comparative Fiscal Ratios in 1992

Norway

T ~ X ~ S / G D P ~ 46.9

Total Outlays/~~pb 55.1

Direct spending/~~pC 26.0

rans sf ~ ~ S / G D P ~ 22.6

Interest Payments/GDP 3.7

Def icit/GDP 2.8

Net Debt/GDP -17.2

Italy

40.7

51.3

20.7

20.3

11.4

9.5

105.3

Japan

30.6

25.7

15.0

11.5

3.9

-1; 8

4.2

Germany

43.7

45.7

22.9

n.a.

3.3

2.8

24.4

France

43.6

48.5

22.3

24.8

3.4

3.9

30.1

a. Direct taxes, indirect taxes, and social insurance contributions. b. Purchases on current account. c. Government consumption plus investment. d. Includes Social Security benefits, but excludes subsidies. Source: OECD.


Table 4

Public Expenditures and Receipts, 1992

Receipts (percent of GDP)

Direct and indirect petroleum taxes t Other direct taxes

Social Security contributions Other indirect taxes Income from government wealth

Total receipts

Expenditures (percent of GDP)

Public consumption Net investment in fixed capital Transfers - private households - subsidies - abroad Interest Increase in capital deposits in state enterprises (net)

Total expenditures

Deficit

Source: Revised National Budget 1993 St.meld. nr.2 (1992-93), Ministry of Finance (May 1993).


Generation's Net Age i n 1992 Payment

Future Generations 305.4

Table 7

The Composition of Male Generational Accounts (r=.04, g=.0075)

Present Values of Receipts and Payments

(thousands o f do1 lars)

Payments Receipts

VAT

62.4 65.8 69.0 71.8 71.1 69.1 64.0 58.7 53.7 47.8 41.8 35.0 28.6 22.2 16.8 12.3 9.1 6.8 5.0 3.7

EX1 EX2 SST YTX WTX

2.6 3.1 3.7 4.2 4.7 5 -3 6.0 6.7 7.1 7.4 7.5 7.2 6.9 6.0 4.7 2.8 1.6 1 .o 0.9 0.8

OLD HOS EDU PEN DIS SIK FAM UNH OTH

Percentage Change 133.3

Source: Authors1 calculations.


Generationls Net Age i n 1992 Payment

Table 8

The Composition of Female Generational Accounts (r=.04, g=.0075)

Present Values of Receipts and Payments

(thousands of do1 lars)

Payments Receipts

VAT EX1

62.9 15.7 66.4 16.7 69.4 17.6 72.5 18.7 72.0 18.7 71.0 17.8 66.6 15.9 61.9 14.6 57.5 14.0 52.1 13.1 46.3 11.5 39.8 9.4 33.4 7.5 26.6 5.5 20.7 3.3 15.2 1.9 10.9 1.1 7.8 0.8 5.3 0.6 3.4 0.3

SST

43.7 52.3 61.1 70.6 76.8 78.6 74.1 68.3 61 -6 51.4 39.4 27.1 17.1 9.3 5.2 4.0 3.0 2.2 1.7 1.2

YTX

39.4 47.2 55.1 63.7 69.8 72.9 71 -4 69.0 65.1 57.0 46.8 35.5 25.8 17.6 11.5 8.0 5.9 4.2 2.7 1.6

WTX

1 .o 1.2 1.4 1.6 1.7 2.0 2.1 2.2 2.4 2.7 2.9 2.8 2.6 2.4 2.1 1.8 1.6 1.2 0.9 0.8

OLD HOS EDU PEN D I S S I K FAM UNM OTH




Table 9

The Components of Male Generational Accounts (r=.06, g=.015)

Average Annual Values of Receipts and Payments

Payments Receipts

Generations Net VAT EX1 EX2 SST YTX UTX OLD HOS EDU PEN DIS SIK FAM UNM OTH Age 0 i n 1992 Payment

Year 1992 2002 201 2 2022 2032 2042 2052 2062 2072 2082

Generations Net VAT EX1 EX2 SST YTX UTX OLD HOS EDU PEN DIS SIK FAM UNM OTH Age 10 i n 1992 Payment

Year 1992 2002 201 2 2022 2032 2042 2052 2062 2072


Table 9 (Continued)

Generations Net VAT Age 20 i n 1992 Payment

EX2 SST YTX UTX OLD HOS EDU PEN DIS SIK FAM UNM OTH

Age Year 20 1992 30 2002 40 2012 50 2022 60 2032 70 2042 80 2052 90 2062


SST YTX UTX OLD HOS EDU PEN D I S SIK FAM UNM

Year 1992 12740.3 2975.6 2002 17496.1 3033.3 2012 20341.4 3336.6 2022 12929.9 3137.1 2032 -11056.6 2683.5 2042 -15662.8 2261.5 2052 -19604.9 2178.0

Generat ions Net VAT Age 40 i n 1992 Payment

SST YTX UTX OLD HOS EDU PEN DIS SIK FAM UNM OTH

Age Year 40 1992 16236.4 2814.9 50 2002 18876.9 3096.3 60 2012 11968.8 2911.2 70 2022 -11459.5 2490.3 80 2032 -15734.1 2098.7 90 2042 -19392.4 2021.2


Table 9 (Continued)

Generations Net VAT EX1 EX2 SST YTX WTX OLD HOS Age 50 i n 1992 Payment

EDU PEN DIS SIK FAM UNM OTH

Age Year 50 1992 17517.8 2873.4 821.2 481.5 7756.7 8874.6 332.8 -8.3 -188.2 - 60 2002 11105.2 2701.6 699.3 624.4 6325.8 7987.1 501.8 -8.9 -340.8 70 2012 -10707.3 2311.0 573.0 436.1 1548.8 5382.3 713.2 -183.0 -615.8 80 2022 -14674.1 1947.6 269.5 418.3 731.2 3072.0 480.2 -553.6 -919.5 90 2032 -18069.0 1875.6 203.5 839.7 534.4 1425.0 337.0 -2116.4-1048.3

FAM UNM OTH Generations Net VAT EX1 EX2 SST YTX WTX OLD HOS Age 60 i n 1992 Payment

EDU PEN DIS SIK

Age Year 60 1992 10402.4 2507.1 648.9 579.5 5870.3 7412.1 465.7 -8.3 -316.2 70 2002 -8848.6 2144.6 531.8 404.7 1437.3 4994.8 661.9 -169.9 -571.4 80 2012 -12529.8 1807.4 250.1 388.2 678.5 2850.8 445.6 -513.8 -853.3 90 2022 -15680.3 1740.6 188.9 779.3 496.0 1322.4 312.7 -1964.0 -972.8


EDU PEN DIS SIK FAM UNM OTH I

W CI I

Age Year 70 1992 -5662.1 1990.2 493.5 375.6 1333.8 4635.1 614.2 -157.6 -530.3 80 2002 -9078.3 1677.2 232.1 360.2 629.7 2645.5 413.5 -476.8 -791.9 90 2012 -12002.0 1615.3 175.3 723.2 460.2 1227.2 290.2 -1822.6 -902.8


EDU PEN DIS SIK FAM UNM OTH

Age Year 80 1992 -7720.1 1556.5 215.4 334.3 584.3 2455.1 383.8 -442.4 -734.9 90 2002 -10433.3 1499.0 162.6 671.1 427.1 1138.8 269.3 -1691.4 -837.8

Generations Net VAT EX1 EX2 SST YTX UTX OLD HOS Age 90 i n 1992 Payment

EDU PEN DIS SIK FAM UNM . OTH

Age Year 90 1992 -7368.5 1391.1 150.9 622.8 396.4 1056.8 249.9 -1569.6 -777.4

Source: Authorst calculations.


Table 10

The Components of Female Generational Accounts (r=.06, g=.015)

Average Annual Values o f Receipts and Payments

Payments Receipts

Generat ions Net VAT EX1 EX2 SST YTX WTX OLD HOS EDU PEN DIS SIK FAM UNM OTH Age 0 i n 1992 Payment

Year 1992 2002 2012 2022 2032 2042 2052 2062 2072 2082

Generations Net VAT EX1 EX2 SST YTX WTX OLD HOS EDU PEN DIS SIK FAM UNM OTH Age 10 i n 1992 Payment

Age Year 10 1992 -3673.5 1397.1 20 2002 -380.1 2288.7 30 2012 3931.4 3455.2 40 2022 6522.3 3522.2 50 2032 9580.0 3874.4 60 2042 2620.6 3642 -7 70 2052 -17303.2 3116.0 80 2062 -19883.0 2626.0 90 2072 -21529.2 2529.0


Table 10 (Continued)

WTX OLD HOS Generations Net VAT Age 20 i n 1992 Payment

EX2 SST YTX EDU PEN DIS SIK FAM UNM OTH

Year 1992 2002 201 2 2022 2032 2042 2052 2062


SST YTX WTX OLD HOS EDU PEN DIS SIK FAM UNM OTH

Year 1992 3385.7 2975.6 2002 5616.9 3033.3 2012 8251.2 3336.6 2022 2284.5 3137.1 2032 -13788.4 2683.5 2042 -16010.0 2261.5 2052 -17427.7 2178.0


SST YTX WTX OLD HOS EDU PEN DIS SIK FAM UNM OTH

Age Year 40 1992 5212.5 2814.9 50 2002 7657.8 3096.3 60 2012 2140.5 2911.2 70 2022 -11973.7 2490.3 80 2032 -14035.4 2098.7 90 2042 -15351.1 2021.2


Table 10 (Continued)



Age Year 50 1992 7110.0 2873.4 60 2002 2028.0 2701.6 70 2012 -9437.6 2311.0 80 2022 -11350.9 1947.6 90 2032 -12571.8 1875.6


EX2 SST YTX OLD HOS EDU PEN DIS SIK FAM UNM OTH UTX

Age Year 60 1992 1937.6 2507.1 70 2002 -8200.6 2144.6 80 2012 -9976.2 1807.4 90 2022 -11109.2 1740.6


EX2 SST YTX FAM UNM OTH UTX OLD HOS EDU PEN DIS SIK

Age Year 70 1992 -6052.3 1990.2 80 2002 -7700.0 1677.2 90 2012 -8751.4 1615.3



Age Year 80 1992 -7917.8 1556.5 90 2002 -8893.5 1499.0



Age Year 90 1992 -9293.2 1391.1

- -



Table 11

The Composition o f Norwegian and U.S. Generational Accounts (r=0.04, g=0.0075)

Present Values o f Receipts and Payments (thousands o f do l l a rs )

Uni ted States Norway

Age Net Income Payro l l Excise Social Health Other Net Income Payro l l Excise Social Health Other i n Payment Taxes Taxes 8 Other Secur i ty Benef i ts Welfare Payment Taxes Taxes 8 Other Secur i ty Benefi ts Welfare 1992 Taxes Benef i ts Benefi ts Taxes Benef i ts Benef i ts

HALES 0

10 20 30 40 50 60 70 80 90

Future Generations

FEMALES 0 59.2

10 76.0 20 91.1 30 73.6 40 31.2 50 -39.0 60 -117.9 70 -133.4 80 -92.3 90 -9.8


Percentage Di f ference 90.3

Source: Authorsr calculat ions.


Table 12

The Changes i n Generational Accounts Required to Equalize Burdens on Newborns and Future Generations

Present Values of Receipts and Payments (thousands of dollars)

Increasing VAT Increasing SST Reducing PEN by 48.0 percent by 36.8 percent by 51.7 percent

Generation's Age i n 1992

MALES:

Future Generations -144.3 -143.3 -165.6

FEMALES:

Future Generations 23.0 8 .8 4.6



Appendix: Data Sources

Population The projection of the Norwegian population through 2200 is taken from

Gjersem (1993). It is based on estimates to 2050 made by the Central Bureau of Statistics and used in the Long Term Program 1994-1997. We assume a constant fertility rate of 1.89 (observed in 1990) and a net inflow of immigrants of 5,000 persons a year. Mortality rates are projected to decline gradually through 2010, leading to an expected lifespan of 75 years for males and 81.6 years for females.

Wealth Our calculations of generational accounts are not based on the conven-

tional definition of wealth in the national accounts, primarily because we include natural resource wealth. Since Norway's petroleum reserves are not marked to market, the petroleum wealth estimate is calculated as the present value of expected net future cash flow, assuming a given time path of oil prices and field-specific natural gas prices, investment outlays and production costs, as well as a projection of the future speed of resenre depletion. 9 Given that future oil prices, production costs, reserves, and other factors are highly uncertain, estimates of petroleum wealth are very sensitive to assumptions. As illustrated in appendix table 1, they are also sensitive to the interest rate used to discount future streams of government income from oil and gas.

Existing data on public wealth are incomplete and generally are not based on market values. Our estimates, reported in appendix table 2, must therefore be viewed cautiously. Hydroelectric power wealth is the present value of the government's net cash flow from its hydroelectric power plants. It is calculated as the sum of the replacement value of the fixed capital invested in this sector and the present value of supernormal rents on that capital. The Long Term Program 1994-1997 estimates the latter to be 90 billion kroner, or $3,153 per capita, in 1992.

The estimated value of shares and equity capital has been provided by the Ministry of Finance. The government owns about 20 percent of the total stock of the Oslo Stock exchange. Another important asset is the public telephone company. Its value is estimated simply on the basis of a crude cash flow projection. We have not attempted to estimate the values of other public enterprises.

Transfers Age and sex profiles for family allowance, disability pensions, old-age

pensions, and other Social Security benefits are constructed on the basis of the 1990 Income and Wealth Survey, which contains information on 22,349 individuals (0.53 percent of the population), 17,676 of whom are over age 12. Individual tax returns are linked to the data collected by the survey. The various tax and transfer age-sex profiles were smoothed using a seven-period moving average, with weights reflecting the number of observations in each age group.

To account for the expected average growth in per capita old-age pensions, we use estimates provided by the Central Bureau of Statistics'

9 The underlying cash flow data were provided by the Ministry of Finance and are the same as those used in the Long Term Program 1994-1997.


microsimulation model MOSART. Appendix figure 1 shows the projected value of the average pensions of 70-year-old males and females relative to the minimum pension G, The latter is the pension that each Norwegian receives starting in the year he or she reaches age 67, assuming no past labor market participation. The Norwegian parliament chooses each year's value of G. While the general intent is that G will rise over time to keep pace with inflation and long-run productivity growth, during recent years the growth in G has fallen short.

Age-sex profiles for sickness allowance are estimated on the basis of individual 1989 data from the KIRUT data base. In 1992, sickness allowance transfers totaled 2.15 percent of GDP. The estimate of the age profile of unemployment benefits is based on recent cross-section unemployment data (which were aggregated into age intervals of five years.) from the Labor Market Directorate.

Education and Health Expenditures In 1992, public expenditures on education and health amounted to 6.8 and

8.0 percent of GDP, respectively. For education, we have adopted coverage rates and costs per student of various educational institutions based on public education statistics. While the age and sex profiles for primary and secondary education are very accurate, we had to resort to a subjective estimate of the age and sex profiles for college education.

Due to incomplete and missing data, most public health expenditures are not distributed by age and sex. Those expenditures that have been distributed (partly on a subjective basis) are for old-age homes, old-age wards and dwell- ings, home nursing and assistance, and other home help. We also estimate an age profile of expenditures on hospitals based on data from a single large hospital in Bergen.

Indirect Taxes and Social Securitv Contributions Our age-sex profile for VATS is estimated from the 1990 Survey of

Consumer Expenditures. This is a survey of 1,201 households containing 3,216 individuals. In distributing household consumption, we assumed that each child under age 17 consumed 70 percent of what adults consume. The 1992 total VAT receipts are adjusted upward to take into account the recent increase in the VAT tax rate from 20 to 22 percent.

Various excise taxes and import duties on gasoline and cars are aggregated into one single age profile based on the 1990 Survey of Consumer Expenditures. Also, excises on tobacco, beer, and other alcoholic drinks are combined into a single age profile based on the same survey.

Age and sex profiles for Social Security contributions are calculated using the 1990 Income and Wealth Survey. Total 1992 Social Security contributions were reduced to take account of the reduction in the payroll tax rate, which offset the 1993 increase in the VAT tax rate.

Income and Wealth Taxation The 1990 Income and Wealth Survey permits a fairly good estimate of the

age-sex profiles of income and wealth taxes. The totals are, however, based on preliminary data. Final tax data for 1992 will not be available until September 1993. Another complication is that the 1992 tax reform makes it difficult to extrapolate from 1991 tax data.


Appendix Table 1

Petroleum Wealth and Permanent Income Based on Alternative Interest-Rate Assumptions

Interest rate (percent)

Petroleum wealth ($ per capita) 26,813 30,199 34,367 39,890 46,171 54,680 65,808

Permanent income ($ per capita) 1,877 1,811 1,718 1,584 1,385 1,094 658

Note: Calculations assume an exchange rate of 6.65 kroner per dollar. Source: Ministry of Finance.


Appendix Table 2

Public wealth

Per cap i ta Percent of GDP

Petroleum wealth $ 34,640 140.9 Hydroelectric power wealth 12,561 51.1 Shares and equity c a p i t a l 5,378 21.9 Other f inanc ia l a s se t s (net ) 10,261 41.3

Total public wealth $ 62,840 255.6 Note: The calcula t ions a re based on a 4 percent discount r a t e and an exchange r a t e of 6.65 kroner per do l l a r . Source: Ministry of Finance.
